10.3 Business Disability (Key Person, Buy-Sell, BOE)

Disability income concepts extend beyond the individual to protect businesses when an owner or essential employee becomes disabled. The exam tests three distinct business DI products, each solving a different problem: Key Person disability (replaces lost productivity), Disability Buy-Sell (funds an ownership transfer), and Business Overhead Expense (BOE, keeps the doors open). Confusing what each one pays for is the most common error.

Key Person Disability Insurance

A key person is an employee whose disability would cause the business a measurable financial loss - a top salesperson, a lead engineer, a rainmaking partner.

Benefits help the business survive the productivity gap until the key person recovers or is replaced. Coverage is usually a lump sum or a limited monthly benefit over 1-2 years.

The amount of key person coverage is justified to the underwriter by quantifying the employee's economic contribution - revenue generated, accounts managed, or the cost to recruit and train a replacement. Because the business is both the policyowner and the beneficiary and the insured employee receives nothing directly, the employee's written consent is generally required before the policy is issued.

Disability Buy-Sell Insurance

A buy-sell agreement obligates remaining owners (or the business) to purchase a disabled owner's interest. Disability buy-sell insurance funds that purchase so the disabled owner is paid fairly and the business stays under the control of the active owners.

Structure Comparison

Trap: Buy-sell policies use a LONG elimination period (commonly one to two years) because the owners want to be certain the disability is permanent before triggering an irreversible buyout. Key person and BOE use much shorter waiting periods.

Two Buy-Sell Arrangements

• Cross-purchase - each owner buys a policy on every other owner; surviving owners use proceeds to buy the disabled owner's share.
• Entity (stock-redemption) - the business owns one policy per owner and redeems the disabled owner's interest.

In a three-owner firm, a cross-purchase plan requires N×(N-1) = 3×2 = 6 policies, while an entity plan requires only 3 policies - a frequently tested counting trap.

The cross-purchase plan gives the surviving owners a stepped-up cost basis in the interest they purchase, an advantage for later taxation, but it becomes administratively heavy as the number of owners grows (a four-owner firm needs twelve policies). The entity plan is simpler to administer but the surviving owners receive no basis step-up. The buy-sell agreement should also fix the valuation method - book value, fixed price, or an agreed formula - so the payout amount is not disputed at claim time.

Business Overhead Expense (BOE) Insurance

BOE reimburses the ongoing fixed expenses of a small business or professional practice when the owner is disabled - rent, utilities, employee salaries, lease payments, insurance premiums. It does not replace the owner's personal income (that is what individual DI does).

What BOE Covers vs. Does Not Cover

Tax and Reimbursement Mechanics

• BOE premiums are tax-deductible as a business expense, so the benefits are taxable as income.
• BOE is a reimbursement contract: it pays actual covered expenses up to the monthly maximum, not a flat amount. If actual expenses are below the maximum, only the actual amount is paid; unused amounts may carry forward to later months in some contracts.
• Benefit periods are short (commonly 1-2 years) and elimination periods are short (30-90 days) because overhead must be paid quickly.

Worked Example - BOE Reimbursement

A dentist's BOE policy has a $12,000/month maximum. In a given month her covered overhead totals $9,500.

The insurer reimburses the actual $9,500, not the full maximum.

Three Business Uses, Three Different Owners

Business disability questions test which product fits which business need, and the key is identifying who owns the policy and who receives the benefit. Key person disability is owned by and pays the business to offset lost revenue and the cost of replacing a disabled key employee; premiums are not deductible and benefits are received tax-free by the business. A disability buy-sell policy funds the purchase of a disabled owner's share by the business or the other owners, usually after a long elimination period, so the buyout triggers only for a lasting disability.

Business overhead expense (BOE) reimburses the actual fixed operating costs — rent, utilities, staff salaries, leases — of a disabled owner's business, but not the owner's own salary, and only up to the lesser of actual expenses or the monthly maximum.

Worked point: If a BOE policy has a $12,000 monthly maximum and the business incurs $9,500 in covered overhead, the insurer reimburses the actual $9,500, not the full maximum; the $2,500 difference may be carried forward in some contracts. BOE is a reimbursement benefit, so it never pays more than the covered expenses actually incurred.

Exam Trap: BOE does not cover the owner's own salary or profit, only the business's fixed operating expenses. A question that includes the owner's compensation in the BOE claim is testing this exclusion.